Offshore move may be prescription for Walgreen

Walgreen Co. is at a crossroads, but it may not be “at the corner of happy and healthy” as its advertising slogan suggests.

The nation’s largest drugstore chain is considering a move that would allow it to significantly cut its tax bill and increase profits. But it’s being painted by critics as un-American for looking to make money for shareholders through financial engineering at the expense of the communities that it grew up in. Walgreen is considering a so-called corporate tax inversion, in which an American company is able to incorporate abroad by acquiring a foreign company. The buyer, in effect, becomes a subsidiary of a foreign parent.

Walgreen would accomplish an inversion by completing its purchase, which is expected to happen in early 2015, of Switzerland-based Alliance Boots and moving its corporate home to Europe’s largest pharmacy chain.

The Deerfield, Ill.-based company faces a tough choice, one in which it must balance profits with corporate social responsibility. By going ahead with an inversion, Walgreen would give ammunition to critics who claim the company is essentially renouncing its U.S. citizenship.

The decision could alienate the consumers who put their confidence in the chain since its inception in 1901, making it one of America’s trusted brands.

Millions of people depend on Walgreen to dispense their prescription drugs safely and responsibly. Its more than 8,000 pharmacies are everywhere — one-stop convenience stores where you pick up your Lipitor as well as your lipstick. The company likes to say that 75 percent of the American population lives within five miles of a Walgreens store.

The average person who pays taxes cannot take advantage of the tax loopholes exploited by corporations, and they don’t think it’s fair, said Klaus Weber, associate professor of management and organizations at Northwestern University’s Kellogg School of Management.

I do think people now more than before care because of rising issues of income inequality and justice and the fact that large companies have come under more scrutiny,” Weber said. “People expect corporations to fulfill their citizen duties as taxpayers like everyone else.”

While several U.S. companies have moved to lower-tax countries since 2012, Walgreen has caught the attention of taxpayer groups and unions that have criticized the potential tax maneuver. They have blasted Walgreen for contemplating fleeing the United States even though it benefits from government insurance programs. Nearly one-quarter of Walgreen’s $72 billion in sales in its last fiscal year came from Medicaid and Medicare, according to a report by Americans for Tax Fairness and Change to Win Retail Initiatives, a union-backed group.

“It is unconscionable that Walgreen is considering this tax dodge — especially in light of the billions of dollars it receives from U.S. taxpayers every year,” Nell Geiser, associate director of Change to Win Retail Initiatives, said in a statement. “Walgreen should show its commitment to our communities and our country by staying an American company.”

In an inversion, Walgreen would still pay U.S. income taxes but much less than the approximately 37 percent effective tax rate (including state and local taxes) it now pays for its U.S.-based business, corporate tax experts said. One stock analyst estimated that a Walgreen inversion would cost U.S. taxpayers $2.35 billion in the first three years after the transaction.

Illinois Sen. Dick Durbin, without citing Walgreen directly, said he hoped U.S. companies would not pursue such a path. He put his opposition in patriotic terms.

“I am troubled by American corporations that are willing to give up on this country and move their headquarters for a tax break,” Durbin, a Democrat, said in an interview. “It really speaks to your commitment.”

Despite political pressures, Walgreen Chief Executive Greg Wasson confirmed for the first time last week that the company is mulling a move overseas to cut taxes. In a conference call with analysts, he said the company is “looking at everything” to improve its bottom line, including its tax structure related to its expected purchase of Alliance Boots and “what the structure could do as far as our effective tax rate.”

A Walgreen spokesman declined further comment.

Walgreen joins a small but growing number of U.S. multinationals contemplating inversions to lower their tax burden. The drugstore chain would be among the first retailers to consider the tax strategy. The top U.S. corporate tax rate is 35 percent, higher than that of England, Ireland, Switzerland and other European countries. The U.S. also taxes foreign profits when they are brought back home. The policy has led other multinationals to stash foreign profits overseas to avoid the repatriation tax.

But few U.S.-based multinationals pay anywhere near 35 percent of their profits in taxes because of numerous loopholes in the tax code. One of the larger loopholes involves the deduction of executive stock options by the company issuing them.

Inversion is one of the many strategies companies employ to reduce their tax burden. If accomplished through a cross-border merger, it requires foreign shareholders to have 20 percent ownership of the combined company. With a foreign parent company, a multinational can strip income out of its American tax base, which would lower its state income taxes too.

The tax savings also come without requiring the chief executive officer, other executives and administrative staff to relocate to the new corporate headquarters.

Reincorporating overseas is a loophole that the federal government has tried unsuccessfully to close several times, most recently in 2004. That year, the government changed the rules to increase the foreign ownership requirement to 20 percent.

Nevertheless, fresh waves of companies have moved or are considering moving to avoid taxes, in part because mergers and acquisitions have increased since the recession. Pharmaceutical and medical device companies are leading the way.

Minneapolis-based Medtronic Inc. agreed to purchase Covidien PLC for $43 billion and reincorporate in Ireland, which would lower Medtronic’s tax rate and allow the company to access its $12 billion in cash held offshore without paying U.S. taxes.

Pfizer Inc. had $69 billion overseas at the end of 2013. The maker of Lipitor kept getting rejected by British drugmaker AstraZeneca PLC in a takeover fight that Pfizer abandoned last month.

Rivals have noticed and pursued similar transactions for fear of being at a competitive disadvantage. North Chicago-based AbbVie Inc. disclosed earlier this month that its $46 billion bid for Shire PLC was rejected by the Irish drugmaker. By moving its tax domicile, AbbVie said it would have lowered its tax rate to 13 percent from 22 percent.

The deal-making has sparked political concerns about corporate tax maneuvers. Sen. Carl Levin, a Michigan Democrat, introduced a bill last month that would raise the foreign-ownership rule on inversions from 20 percent to 50 percent.

Since the proposal lacks Republican support, it hasn’t deterred companies from pursuing cross-border mergers to enable an inversion, said Robert Willens, a New York-based corporate tax adviser.

AbbVie said last week it would like to renew talks with Shire, but it hasn’t ruled out launching a hostile bid. Shire had said AbbVie’s offer undervalued its growth prospects.

Back in March, Walgreen CEO Wasson said the company had no plans to do an inversion. But hedge funds and other investors have been pressuring Walgreen to consider the maneuver and other shareholder-friendly actions.

In 2012, the company acquired a 45 percent stake in Alliance Boots and the right to purchase the remaining interest starting in February. The current structure of the transaction will not qualify for an inversion, but Wasson told analysts that Walgreen is evaluating potential changes to the capital structure of the merger with Alliance Boots.

From a rational shareholder perspective, an inversion would have a big upside for Walgreen. By moving to Switzerland or England, Walgreen could reduce its effective tax rate from 37 percent to 24.2 percent in its 2016 fiscal year, according to one analyst. That would save the company an estimated $783 million in taxes in the first year, according to a report issued this month by Meredith Adler of Barclays, an investment bank.

With the tax savings, Walgreen’s estimated earnings in its 2016 fiscal year would rise to $6.50 per share, from $5.51 per share, an 18 percent increase, Adler estimated. The extra profits could be used to make acquisitions, build new stores and create jobs, or the cash could be returned to shareholders in the form of dividends or stock buybacks.

“I don’t know if Las Vegas is taking odds on Walgreen inverting, but I would put a lot of money” on the company pulling it off, Willens said.